A Soft Evans Rule In Place
So in the end, we got about what I expected from the Fed. Operation Twist was extended, and actually a bit more than I thought they would be able to extend it as the program will continue through year-end.
I said that I would “look for signs that an Evans-type rule is being implemented,” and we got a hint of that as well. Remember, the “Evans Rule” is a conditional policy directive modeled after Chicago Fed President Evans’ suggestion that the FOMC should provide easy money until unemployment falls below 7% or core inflation rises above 3%. Obviously, the parameters “7%” and “3%” are where the rubber meets the road – without parameterization, the policy reduces to roughly what the Fed said in its statement:
“The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
Put “an unemployment rate below seven percent” in place of “sustained improvement in labor market conditions” and “core price inflation at or below three percent” in place of “price stability,” and you have exactly the Evans Rule. I doubt most of the Committee would accept 3% as an acceptable level for core inflation, but by backing into the Rule in this way the FOMC can argue later about what those parameters actually are.
Bernanke reinforced the point in his after-meeting presser, when he made clear that this didn’t mean that stability at 8.2% unemployment would be okay. He said “If we don’t see continued improvement in the labor market, we’ll be prepared to take additional steps if appropriate.” Moreover, the Fed is willing to consider further asset purchases and “still has ammunition.” (So you see – they’re relevant!)
Since I think the Unemployment Rate is fairly likely to rise, or at least not to fall, from this level, I believe the QE3 crowd got about the best that they could reasonably hope for. There was no sign leading into the meeting that policymakers were thinking seriously about another large-scale asset-purchase (LSAP) program, so it would have been a true shock if one had been delivered. If Greece had already exited the Euro, we probably would have seen it, but otherwise they will take their time to “communicate the strategy clearly” over the next month and a half. That communication will probably not take the form of outright speculation that some more LSAP is needed; with the ball teed up, all speakers need to do is lament the failure of the labor market to do better and the implications are already writ clearly.
It makes sense to go slow here. The economy is weakening, but not plunging. The crisis in Europe is less urgent, for today. The Twist has been extended, so they’re not standing idly by, and they’ve satisfied the importance of appearing relevant and concerned with their statement and promise of great things to come in the future. The ECB two weeks ago didn’t ease, and the MPC of the Bank of England narrowly voted against Chairman Mervyn King (in a true democracy, the Chairman sometimes loses), who was seeking to expand the BOE’s bond purchase program. The MPC said there was “merit in waiting” to see how things play out in the next few weeks in Europe.
To me, it sounds like July and August will see the next round of QE commence, probably from all major central banks, unless somehow the situation in Europe really does seem to be moving towards an extended period of calm and/or U.S. growth springs forward abruptly. I don’t see either of those things happening, but the benefit from waiting is that they might. In the meantime, the only thing the Fed loses is an extra couple of weeks goosing the stock market, but they can get that anyway once the communication strategy commences in earnest.
The data mill churns tomorrow after a couple of days off, with Initial Claims (Consensus: 383k from 386k) tomorrow along with Philly Fed (Consensus: 0.0 from -5.8) and Existing Home Sales (Consensus: 4.57mm from 4.62mm). The Philly Fed number is the most interesting one, as economists are expecting a significant rebound from last month’s 14-point decline. I’m not sure why I’d look for a bounce; the NY Purchasing Managers’ Index also dropped sharply in May and the Empire Manufacturing figure fell sharply in June. I wouldn’t be expecting a big jump from Philly Fed.
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What is your prognosis for the core to hit that 2.9 – 3 per cent target?
It probably won’t get there in 2012, but should reach it in 2013.
The Fedsters are like a posse of alcoholics who regard their addiction as not merely benign, but actually salubrious. Believing higher proof beverages to be more efficacious than low, they have rolled out Operation Twist to gradually shift their keg beer habit over to gin-and-tonics with a ‘twist’ of lime. Line up the glasses, girls, the FOMC’s in town!
Should this change in the composition of their ‘liquid assets’ fail to yield results, there’s always Quantitative Inebriation — upping their daily intake, until some bleary-eyed PhD Econ falls off a barstool and gets hurt.
You just know this is gonna turn out well … /sarc
Great call on Philly. The interesting thing is we now seem to be out of the bad is good phase we’ve been in the for the past few weeks. My guess is we wont start seeing that until we get close to the next fed meeting, and there is plenty of time for plenty more bad data in the meantime.
commodities are still getting shellacked. At some point, they will be the trade of the century–but I suspect not in the immediate future. I’d like to see equities retest last summer’s lows before I bit on commodities too hard–though i am testing the waters. Agree?
Also: why are gold shares getting pounded so much harder than the metal? I read something about political instabilities and environmental regulations. but that doesn’t explain the huge moves on risk-off days like today. One would think that with crude getting hammered, gold shares would at least not decline as much as gold, since it takes oil to mine. Thoughts?
Last thought: you and Hussman are my two favorite pundits. The one major disagreement the two of you would have is that, for the last 2 years or so, Hussman has been predicting that inflation would be very moderate in the first half of this decade as the positive effects of fed action would flounder, and then explode in the last part when they came home to roost. Do you think recent action in commodities, etc. support this?
How can I not reply when someone puts me in the category of Hussman? One way I’ve got him beat: frequency. 🙂
Commodities: when an investment represents great value, I’ve learned not to try to time it too finely. If it’s a 10% trade, then you wait. If it’s a 100% trade, then how much does the next 10% matter? And I think this is a value trade.
Gold shares – I think they’re inordinately held in accounts that were viewing commodities shares as dividend-paying substitutes for direct commodity investments, and as inflation fears inexplicably wane, people are blowing out of these ETFs and therefore indirectly blowing out of the shares. But unlike commodities, for which there is a natural end-user demand that will ensure a steady bid at SOME price, there’s not as deep a natural bid for a particular stock. China stands ready to buy all the copper in the world at some price, but how many shares of Anglo-American?
Hussman: Commodities’ travails will help keep headline inflation below core inflation for a little while, but if core keeps rising then might both be right. I view core around 2.6-2.7% by the end of this year and over 3% next year as my point estimate, but that will still produce headline inflation around 2% this year and not above 3% until a year from now (unless gasoline suddenly reverses, which it may). If commodities are reflecting a growth scare, and Hussman thinks slow growth means lower inflation, then they’re consistent – but they’re both wrong. Personally I think it’s getting fashionable to be short commodities, and it’s hard to find anyone who is bullish besides Jim Rogers. And Goldman, I think.
Thanks for the note and the wonderful compliment! Tell your friends! 🙂
Thanks for the great reply! (and yes, you do beat Hussman for frequency, which I greatly appreciate–even if the added value of the frequency is mostly entertainment value.) You also answer questions, which is great!
I hadn’t really noticed that other commodity producing shares were lagging commodities as much as gold shares were lagging gold. But they certainly did today. I wonder if it is time to start nibbling on them too.